MacroeconomicsSection3 -...

Economics 2003-04: Macroeconomics Page 1SECTION 3: MACROECONOMICS3.1 MEASURING NATIONAL INCOMEMethods of Calculating National Income•There are three methods of calculating national income:•The expenditure method: oThis adds up all the spending in the economy: C + I + G + X - M. oIt is called Gross Domestic Product (GDP) at market prices and includes:C: ConsumptionI: Investment which includes: Planned investment in capital, Unplanned increases in stocks or inventoriesG: Govt. spending on goods and services. Because they are often provided free of charge (no market value), they are valued at cost.X: Exports: the domestic economy receives the moneyM: Imports: these must be subtracted because it is spending on goods and services from outside the domestic economy.•The income method: adds up all the sources of income in the domestic economy. oTransfer payments (pensions, unemployment and welfare benefits) are excluded: no good or service is produced for the income. oIncome includes:Wages and salariesSelf-employed incomeProfits: divided into dividends given to shareholders and undistributed or earnings retained by the firmRent which includes the cost of raw materials and intermediate inputs and imputed rent on any owner occupied housingInterest•The output method:oAdds up the value added by a firm’s production:The value of the firm’s output minus the value of inputsoAlternatively this method adds up the output of final goods and services.•If $100 worth of goods and services has been produced (output method) this must have generated $100 worth of income (income method) for the various factors of production and will lead to $100 worth of spending (expenditure

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Page 2 Economics 2003-04: Macroeconomicsmethod).•If people do not buy some, firms end up with stocks of unsold goods which are included in investment and assumes the firms ‘bought’ the goods for themselves.•For this reason GDP = National Income = National Output.•If spending by households is added up this will show the spending at market prices. But this does not truly reflect income earned by factors because of indirect (sales) taxes paid by firms to govt. and subsidies received by firms from govt. Therefore:Market price - indirect taxes + subsidies = factor cost.Adjustments to National Income Accounts•Gross Domestic Product (GDP): the value of final goods and services produced by factors within the domestic economy. It must be adjusted to exclude:oGoods made in previous years and sold this year oCapital gains which are just a redistribution of benefits.

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